Wells Fargo still loves mortgages

You can’t have a Wells Fargo earnings call without talking about mortgages. And boy, did they ever.

For the bulk of the 95-minute call with analysts Friday morning, Wells CEO John Stumpf and CFO Tim Sloan fielded questions from analysts about the bank’s residential home loan business. With interest rates rising drastically in the past month, everyone agreed Wells Fargo won’t continue to see such strong refinance volumes.

Where observers and executives at the top mortgage originator differed is on what happens next. Wells brass believes they can continue growing through new home purchases and other businesses. Analysts seemed skeptical, pressing for an admission that Wells might not be able to keep posting record quarterly profits. They didn't get one.

"Over time we believe we have the right diversified business model, the right people and the right markets to continue growing this company," Stumpf said. "I sure like our chances."

Investors reacted positively to the second quarter earnings of $5.3 billion for common shareholders. The stock has traded up more than 1.7% most of the day to about $42.70, just shy of a 52-week high.

Here are my five observations from the conference call:

1. Mortgage business slowing down

There’s no doubt Wells Fargo’s market-leading mortgage business is slowing down. The lender actually increased its mortgage volume to $113 billion in the previous three months, up from $109 billion in the first quarter. However, clouds are gathering.

Steep interest rate gains (up to 4.5% or more on average for 30-year loans) has taken the wind from Wells’ sails. The pipeline of applications now is at $63 billion, compared to $74 billion on March 31.

“We don’t think we’ll see $100 billion in volume in the third quarter,” Stumpf acknowledged.

When an analysts mentioned some estimates of a 40% decline in mortgage volume the rest of the year, CFO Sloan hesitated to commit to that number. “I don’t think anybody knows what the volume in the mortgage market is really going to be,” he said.

2. Stumpf still loves housing

Despite the looming slowdown, Stumpf remains bullish on housing. He said Wells believes the purchase market will offset some of the lost refinancing business as rates rise. The improving economy, stabilized home prices, pent up demand from new households in recent years and other factors are driving a resurgence in buying, he said.

The opportunity for Wells Fargo is to convert non-mortgage customers into mortgage borrowers, Stumpf said, noting many Wells account holders still get their mortgages other places. “There’s a tremendous opportunity there for us,” he said. “Housing sure has strength to it.”

Additionally, Wells believes it can make more money from its mortgage servicing unit as interest rates climb.

3. Credit quality helped earnings

Wells 14th consecutive quarter of earnings growth was aided significantly by improved credit quality. The San Francisco-based bank reduced its credit losses by $1 billion in the quarter to $1.2 billion from $2.2 billion a year ago. That was good for a loss rate of just 0.58% of all loans.

“Credit performance was very strong in the second quarter with improvement in all key metrics,” said Chief Risk Officer Mike Loughlin. “The consumer loss levels have improved rapidly due primarily to the positive momentum in the residential real estate market, with home prices improving faster and in more markets than expected.”

Analysts wondered if the bank could expect to keep reducing that number. But execs said they do expect to further reduce credit losses if the economy keeps expanding and home prices keep increasing.

4. Good quarter for brokerage

While most folks can’t get past Wells’ mortgage business, one key improvement in the quarter was the bank’s brokerage, wealth and retirement unit. That business, led by Charlotte’s David Carroll, improved its net income by 29% to $434 million in the second-quarter. The unit deals with consumer investment portfolios, high net-worth clients and retirement savings for individuals and institutions.

Stumpf indicated the bank can keep improving its operations as Americans return to the stock market and put more emphasis on saving for retirement. He specifically mentioned the work Carroll was doing to squeeze more from the business.

“We think it’s a big growth opportunity for this company,” he said.

5. Room for more growth

With all the talk of a slowing mortgage business, Stumpf & Co. preached their belief that Wells Fargo isn’t done growing profits, even after 14 quarters of gains.

At one point on the call, analyst Mike Mayo pressed execs to explain how they would replace mortgage revenues that are bound to decline. Stumpf and Sloan responded by offering that Wells has 89 other lines of business in can grow. Sloan pointed out mortgage, for all its fanfare, is only about 10% of the lender’s revenue. “We have 90 different businesses,” he said. “This is a portion of our business.”

Mayo asked which horses would do more pulling if mortgage goes lame. Stumpf’s response: “All of them.”

Upon further explanation, execs indicated reduced lower credit costs and additional revenue from other improving consumer lines could replace the lost mortgage business. Stumpf nted the healthier housing market would prompt homeowners to spend more on credit cards, make large purchases again and in general do more business with the bank in other places because they’re no longer worried about their home.

Footnotes

One of the interesting things that sets Wells Fargo apart from its Wall Street banking brethren is its more conservative Main Street culture. That was apparent Friday when Stumpf discussed the state of his investment banking business. When an analysts asked about the i-bank's market share, Stumpf indicated it was growing, but offered this assessment:

"We're not in this business for market share. We're in it to serve our customers that want those services."

It may seem like a simple response. But I can tell you from covering several large banks, it's not a conventional way to look at investment banking. Charlotte-based Bank of America, for example, emphasizes its standing in investment banking league tables every quarter.

Of course, if Wells Fargo ranked No. 1 or No. 2, it might take that same approach.